Government Intervention –  Price Controls
Topic Sixteen

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Price Controls

A price control is a government regulation stipulating the maximum or minimum price that a firm can charge. Price controls are usually justified as a way to help consumers, but those who advocate them often ignore their negative effects. There have been many cases in which governments have been unwilling to let prices adjust to clear markets. Instead, they have established either price ceilings, which are prices above which it is illegal to buy or sell, or price floors, which are prices below which it is illegal to buy or sell.

Price Ceiling

A price ceiling is the maximum price which can be charged by a provider and, above this price, it is illegal to charge. On the other hand, a price floor is the minimum price which a provider can charge below which it is illegal to charge.

Assume that a price ceiling Pc is placed below the market-clearing price Pe. At this price, buyers want to buy more than sellers will make available as can be seen in the following graph.

Figure 1

Buyers would like to buy amount Q3 at price Pc, but sellers will sell only Q1. Because buyers cannot buy as much as they would like at the legal price, there will be shortages. The normal adjustment that this disequilibrium would set into motion in a free market is an increase in price. However, with the price ceiling, buyers or sellers or both will be penalized if transactions take place above Pc. Buyers are faced with the problem that they want to buy more than is available.

Price Floor

Price ceilings are not the only sort of price controls governments can impose. Government also uses minimum prices, or price floors as can be seen in the following graph. In this case, a price floor of Pf was set. It is the minimum price that can be paid as in the case of a farmer. The reason for such a move is in order to allow farmers to have a decent standard of living. At this price, buyers are satisfied but sellers are not. They would like to sell quantity Q3, but buyers are only willing to take Q1. This results in a surplus on the market. To prevent the adjustment process from causing price to fall, government may buy the surplus as some countries do especially in the agricultural sector. If it does not buy the surplus, government must penalize either buyers or sellers or both who may transact below the price floor.

Figure 2

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